Viewpoint -- High Oil Prices Could Help U.S. Manufacturing

Short term pain, long term gain

By Joe Thomas, Dean, Cornell University's Johnson School of Management and a Professor of Operations Management | Aug 08, 2008

The higher oil prices that have shocked American industry and consumers alike may contain more than a silver lining, they present a golden opportunity to propel the U.S. into a more productive and efficient future. The short-term pain of higher transportation costs will turn into long-term gains if national policy aims forward instead of backward.

Both presidential candidates have addressed this issue mostly in response to higher gas prices for consumers. But the responses so far -- more offshore drilling and conservation -- address only part of the problem. A national policy based on alternative energy, natural gas, better mass transportation, more stringent auto mileage standards, tax breaks for greener technologies and offshore drilling (although results will be years in the future) and nuclear energy will be necessary to power up industry and consumers.

As we discovered when the IRS gave tax breaks to consumers who drove gas-guzzling SUVs and classified them as trucks leading to a surge in SUV demand, government can and does affect behavior quite significantly. Of course, private industry must respond as well. The manufacturing industry has taken the lead, with more local production and a more efficient supply chain instituted out of necessity. The days of sourcing lumber in the Pacific Northwest, shipping it to China for production of furniture, and sending it back to Chicago or Dallas as a new dining room table will be less common now that a container from Shanghai to Long Beach costs $8,000, compared to $3,000 less than 10 years ago.

Prices have dropped from $140 a barrel, but the era of cheap oil is over and no amount of debate on tire pressure can change that. Here are five outcomes that are likely if Americans embrace the end of cheap oil and politicians, industry and consumers act accordingly.

The U.S. will keep many of our manufacturing jobs. High oil prices and the devaluation of the dollar have made Asian goods more expensive to purchase and ship, and I believe this will keep the manufacturing sector stable. Many U.S. industries will keep current jobs and transfer fewer jobs offshore. Still, the initial investment required for plants in some heavy industries that have moved overseas is so high that new plants will not be built in some capital-intensive industries. The overall benefit will occur not just for final product assembly, but across the supply chain. Much of the U.S. economic growth comes from small- and mid-sized enterprises, which can provide better customer service and faster response time by keeping their manufacturing local. This competitive advantage will keep their manufacturing jobs in the U.S.

More U.S. auto production. Even though GM and Ford are closing factories and trying to build fewer trucks and more small cars, a transformation that will result in fewer jobs, the overall employment may stay stable -- or increase -- due to foreign investment. With the cost of auto components, including steel, rising, foreign auto firms like Honda, Toyota and Hyundai will purchase more components in the U.S. and assemble cars here, enjoying cost savings in purchasing and transportation and providing additional U.S. manufacturing jobs.

Less Driving. The Federal Highway Administration reported Americans drove 9.6 billion fewer miles in May compared to a year earlier. For the first four months of the year compared to 2007, we drove 40.5 billion less miles. This trend has major implications for train and bus usage and less tax revenue for the nation's highway system. Lower tax revenue is a problem, but less driving and smaller cars will decrease oil consumption and provide side benefits, cleaner air and fewer highway fatalities.

Green Investment. It is now economically feasible to invest in wind, solar and other alternative energies. GE has a two-year backlog on turbines for large windmills. The private sector will find ways to improve the technology and lower the cost for a range of energy sources such as biofuels. But wind and biofuel will not be enough by themselves and industry must discover how to make solar power and other alternative energies economically efficient.

National Energy Policy. For years, gas prices were too low and it made us do things that were not economically justifiable or sustainable. The presidential race features candidates who advocate drilling -- which will take years to produce results -- and to produce more ethanol from corn, which is a mistake in my opinion. Biomass, grass and sugar cane are much more efficient as sources for ethanol than corn. A comprehensive energy policy which incorporates ideas to help manufacturing, the environment, and the economy can be called "all of the above." We need drilling; we need nuclear power; we need renewable energy. Higher energy prices make many of these efficient.

While there is no one magic bullet to solve our energy situation, our dependence on cheap oil can no longer prop up our economy. And that's a good thing.